Press Release - Friday 15th April 2016

The Impact of Brexit on Foreign Investment in the UK

New analysis by the Centre for Economic Performance

Third in the new series of #CEPbrexit policy briefings from the Centre for Economic Performance

Leaving the European Union (EU) would reduce flows of foreign direct investment (FDI) into the UK by more than a fifth, damaging productivity and lowering people's incomes. Cars and financial services - two important UK industries - would receive less investment from foreign firms that use the UK as a base to access EU markets. And the UK's ability to negotiate concessions from regulations on EU-related transactions would be seriously eroded. Overall, incomes could fall by about 3.4% just from lower foreign investment.

The report begins by noting that FDI raises national productivity and therefore output and wages. Multinational firms bring in better technological and managerial know-how, which directly raises output in their operations. FDI also stimulates domestic firms to improve - for example, through stronger supply chains and tougher competition.

So why might FDI fall if the UK left the EU?

First, being fully in the European Single Market makes the UK an attractive location for multinationals as their exports to the EU do not face potentially large costs from tariff and non-tariff barriers.

Second, multinationals have complex supply chains and many co-ordination costs between their headquarters and local branches. These would probably become more difficult to manage if the UK left the EU. For example, component parts would be subject to different regulations and costs; and intra-firm staff transfers would become more difficult with tougher migration controls.

Third, uncertainty over the shape of the future trade arrangements between the UK and EU would also tend to dampen FDI.

The new CEP report analyses bilateral FDI flows between 34 OECD countries (including the UK) over the last three decades to assess the likely impact of Brexit on FDI:

Controlling for many other factors, the baseline estimate is that inflows of FDI into the UK are about 28% higher thanks to membership of the EU. The positive impact is very robust, ranging from 14% to 38% under different statistical assumptions.

Striking a comprehensive trade deal - following Switzerland, for example, in the European Free Trade Association - does not replicate the benefits of EU membership.

Taking a very cautious approach, which suggests only a 22% fall in FDI following Brexit, there will be an estimated decline in UK income levels of 3.4%. This represents about £2,200 of GDP per household. The income losses due to lower FDI are larger than CEP's earlier estimates of the static losses of 1.3% to 2.6% due to lower trade.

Estimates of the impact of Brexit on the UK's car industry imply that UK production would fall by 181,000 cars (12%) and prices would rise by 2.5%. Even if the UK manages a comprehensive trade deal and keeps tariffs at zero, production would fall by 36,000 cars.

The UK's financial services industry is the largest recipient of FDI. If 'single passport' privileges are restricted following Brexit, this would lead to big cuts in activity. The UK would also be unable to challenge EU regulations at the European Court of Justice.

One of the report's authors, John Van Reenen said: "The evidence shows that EU membership has helped substantially drive up foreign investment in the UK. Brexit will inflict collateral damage on foreign investment, causing further losses to productivity and making us poorer as a nation."

Thomas Sampson remarked: "It's pie in the sky to think that a free trade deal with the EU, like the Swiss or Canadian arrangements, would solve the FDI problem. One reason that foreign banks, including the Swiss, flock to the City of London is that they have free access to the European Single Market. We put this in jeopardy by jumping ship."

Swati Dhingra noted: "We estimate that British people could be 3.4% worse off due to lower FDI, which is about £2,200 per household. The car industry has been a British success story, but it will suffer a big blow if we leave."

Gianmarco Ottaviano added: "The heavy economic cost of Brexit might be a price that many people are willing to pay. But as we go down the list of items involved, the bill for British households keeps on mounting."

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